Competition Bureau Statement Regarding its Investigations into First Air, Canadian North and Calm Air

OTTAWA, August 22, 2017 — Today, the Commissioner of Competition (the “Commissioner”) announced that he has completed investigations relating to air passenger and cargo services in Northern Canada under the merger, abuse of dominance and civil competitor collaboration sections of the Competition Act (the “Act”). Footnote 1

The Commissioner’s concluded investigations involved:

  1. a merger between First Air and Calm Air relating to air passenger and cargo services in central Nunavut;
  2. a codeshare agreement between First Air and Canadian North relating to air passenger and cargo services on 16 Northern routes, including the Iqaluit‑Ottawa route; and
  3. allegations of predatory pricing against First Air and Canadian North on the Iqaluit‑Ottawa route.

This statement summarizes the analysis and conclusions of the Competition Bureau (the “Bureau”) for these investigations. Footnote 2

Background: Air Transportation in the North

The Bureau is aware of the unique nature of and essential role that air transportation services play within Northern Canada. In particular, air services in the North are an important transportation link between more remote communities and larger cities. They also play an important role in the economic development as well as in the supply of food, healthcare, and other goods and services in these communities.

Providing air services in the North is unique compared to other parts of Canada because, for example:

  • The climate of the North has challenging and unpredictable weather. This may result in an increased number of cancelled or redirected flights with little notice;
  • The North covers large geographic areas that are not densely populated. This means that demand may be limited;
  • There are fewer paved runways. This means carriers may require specialized equipment to serve many destinations; and
  • Businesses operating in the North may face additional hurdles, such as high fuel costs and challenges finding and retaining staff.

The Bureau’s investigations were mindful of these operating conditions. However, in all cases, its ultimate conclusions are based upon the evidence it obtains and the legal tests required by the Act.

Investigation of the Calm Air and First Air Merger

Context

Before June 2015, First Air and Calm Air were the only providers of scheduled passenger and cargo air services in the central area of Nunavut known as the Kivalliq. The Kivalliq includes the communities of Arviat, Baker Lake, Chesterfield Inlet, Coral Harbour, Rankin Inlet, Repulse Bay, and Whale Cove (the “Kivalliq Region”).

Both airlines offered flight services within and into the area using a combination of large turbo-propeller and single-aisle jet aircraft. Flights were often configured to carry both cargo and passengers.

Each of the airlines’ respective networks provided scheduled services within the Kivalliq Region, and between the Kivalliq Region and southern hubs in Manitoba. Air services are the primary transportation link to the Kivalliq communities.

In June 2015, First Air terminated its operations in the Kivalliq Region. The next month it entered into a set of agreements with Calm Air that included:

  • the sale of First Air’s passenger and cargo contracts as well as other assets including the transfer of certain employees in the Kivalliq Region to Calm Air;
  • a lease agreement whereby Calm Air currently operates 13 flights per week between Winnipeg and Rankin Inlet using aircraft owned by First Air; and
  • a codeshare arrangement whereby First Air could sell seats on Calm Air’s flights within the Kivalliq Region.

Analysis

What is an efficiency gain?

Companies that merge may gain efficiencies in their operations, which can lower their costs. Efficiency gains may include savings related to administration and streamlined operations.

The Bureau analyzed First Air’s termination of service within the Kivalliq Region and its subsequent sale, lease and codeshare agreements with Calm Air under the merger provisions of the Act. The merger provisions of the Act allow the Commissioner to challenge a proposed merger if he determines that it is likely to prevent or lessen competition substantially.

When making this determination, the Commissioner may consider various factors, such as:

  1. the extent of effective remaining competition in a market;
  2. any barriers to entry into a market; and
  3. whether one or both of the merging parties’ businesses is likely to fail.

The Act also contains an efficiency exception (section 96). It introduces a trade‑off in which a merger’s likely efficiency gains are compared to its likely anti‑competitive effects.

In conducting its review of the merger between Calm Air and First Air (the “Merger”), the Bureau spoke with the airlines and obtained certain information from them, including strategic business documents and route‑level financial statements and ticketing data. The Bureau also spoke with third parties, such as competitors, customers and various government representatives regarding competition for air transportation services in the North and in the Kivalliq Region.

In the course of its review, the Bureau retained the services of two independent experts:

  • an economic expert who provided analysis and views on the likely competitive effects of the Merger; and
  • a financial expert who provided analysis and views on the potential efficiencies resulting from the Merger and the financial viability of the airlines.

The economic expert conducted an empirical analysis of the airlines’ passenger and cargo data. This analysis quantified the likely anti‑competitive effects of the Merger or the “deadweight loss”. Deadweight loss is the overall loss to the economy that may result from a merger due to increased prices and/or decreased supply.

When analyzing the competitive effects of the Merger, the Bureau also considered the absence of competing scheduled service providers in the Kivalliq Region, the challenges of operating in the North, and the information provided by stakeholders.

The financial expert reviewed the airlines’ strategic business documents, financials, and route-level data to analyze and quantify the likely efficiencies of the Merger. This analysis revealed that the Merger is likely to result in significant efficiency gains. In addition, the Merger’s efficiencies gains are likely to significantly outweigh its anti-competitive effects. The financial expert also evaluated the financial viability of the airlines before the Merger.

Upon review of the evidence, including the expert analysis, the Bureau did not find a sufficient basis to challenge the Merger.

Investigation into the codeshare agreement between and allegations of predatory conduct by First Air and Canadian North

Context

Codeshare Agreement

On May 13 2015, First Air and Canadian North announced they would enter into a codeshare agreement (the "Codeshare") for the provision of air passenger and cargo services.

A codeshare agreement allows for a flight operated by one airline, to also be marketed by another airline, under their airline’s code and flight number. While variations exist in the specific codeshare agreements, a codeshare agreement generally allows one airline to sell seats on flights operated by another airline.

First Air and Canadian North’s Codeshare was implemented in late July 2015. It covered 16 routes operated by the two airlines, including the trans‑Arctic route, the Ottawa‑Iqaluit route, the Edmonton‑Yellowknife route and certain routes in each of the Baffin, Kitikmeot and Mackenzie Valley regions. The Bureau reviewed the Codeshare under the civil competitor collaboration provision of the Act (section 90.1).

In the course of its investigation into the Codeshare, the Bureau gathered information from numerous third‑parties, including key private and public stakeholders in the North. The Bureau also received information from First Air and Canadian North.

Predatory Pricing Allegations

In April 2016, the Bureau received information suggesting that both First Air and Canadian North were actively trying to prevent GoSarvaq, a new provider of air transportation services, from operating flights linking Ottawa and Iqaluit, one of the routes covered by the Codeshare. It was alleged that First Air and Canadian North offered significantly lower prices for passengers, for flights between May and August 2016 (the “seat sale”) to drive out GoSarvaq. On May 6 2016, GoSarvaq announced that it would terminate its operations.

These allegations of predatory pricing were examined under the abuse of dominance provision of the Act (section 79). Predatory pricing occurs when a company deliberately sets prices below cost for long enough to eliminate, discipline, or deter entry by a competitor. This involves an expectation that the company will be able to recoup its losses later, by raising prices again.

In October 2016, the Bureau obtained orders from the Federal Court under section 11 of the Act to gather additional information from First Air and Canadian North. In assessing the information that would need to be sought in the section 11 orders, the Bureau consulted with an external financial expert. The Bureau received detailed financial information, communications within and between the airlines, and other strategic and business documents.

Analysis

Codeshare Agreement

Shortly after the issuance of the section 11 orders, the Bureau was informed by First Air that it would be terminating the Codeshare as of May 16, 2017.

On May 16, 2017, the Bureau received confirmation that the Codeshare between the two airlines was terminated. This confirmation resolved the Bureau’s concerns with respect to the Codeshare and as such, the Bureau closed its investigation into the potential anti‑competitive effects of the Codeshare.

Predatory Pricing Allegations

The Bureau then focused its efforts on determining whether First Air and Canadian North had engaged in predatory pricing contrary to the Act (section 79). Predatory pricing involves a test in three parts:

  1. whether the airlines possessed market power, or were dominant, on the relevant routes;
  2. whether the airlines have engaged in or are engaging in a practice of anti‑competitive acts (in this case whether they have engaged in predatory pricing); and
  3. whether that conduct has had, is having or is likely to have the effect of preventing or lessening competition substantially.

The Bureau concluded that First Air and Canadian North were dominant on the Iqaluit‑Ottawa route. The Bureau found that barriers to entry for air transportation services in Nunavut are high and relatively distinct from barriers found in other air transportation markets. In addition, the segment linking Ottawa and Iqaluit is an important gateway to the Northern communities.

In assessing whether predatory pricing exists for the purpose of the second criteria of the test, the Bureau seeks to determine whether a firm is deliberately setting the price of products or services below an appropriate measure of cost. The firm would incur losses on the sale of products in the markets for long enough to eliminate, discipline or deter entry or expansion of a competing firm. In this case, the expectation is that the firm engaged in the allegedly predatory conduct would eventually recoup losses by charging higher prices than they would normally charge in the absence of the alleged conduct.

The Bureau conducted an avoidable cost test, consistent with the approach in Commissioner of Competition v. Air Canada. Avoidable costs are the costs that would not be incurred if the airline did not fly an aircraft. The Bureau evaluated whether the revenue generated by the airlines from providing flights between Iqaluit and Ottawa was sufficient to cover the average avoidable cost for providing the service. The Bureau considered revenue from both passenger seats and cargo services.

The Bureau did not find that revenues generated were consistently below the average avoidable costs associated with the operation of flights during the period in which the alleged predatory fares were offered. The Bureau found no evidence that the incumbent airlines were coordinating prices during or outside that same period.

However, the Bureau found evidence to suggest that GoSarvaq was perceived as a threat and deliberate actions, while not contrary to the Act, were taken in response to its announced entry into the market.

The Bureau’s review also found that the incumbent airlines hold certain government contracts that obligate them to operate a certain number of flights on a variety of routes and provide air transportation services at fixed rates. The Bureau recognizes that these types of contracts are essential in the North to ensure universal access to medical facilities for remote communities and airlines may rely on the revenue from these contracts to operate profitable flights on some routes.

Although it is the Bureau’s view that the allegedly predatory pricing promotions by First Air and Canadian North likely had an impact on GoSarvaq’s entry plans, the Bureau did not find sufficient evidence to conclude that these were anti-competitive acts as required by the Act and established by case law. Consequently, the Bureau closed its investigation into the conduct by First Air and Canadian North.

Conclusion

The Bureau is aware of the importance of air transportation services, especially to communities in the North, where alternative transportation options may not be available. Should the Commissioner determine that any conduct engaged in by carriers operating in the North is anti-competitive, within the meaning of the Act, he will not hesitate to take appropriate action. Similarly, should the Commissioner determine that any future consolidation or co-operation among airlines serving the North will result in a substantial prevention or lessening of competition, he will not hesitate to take appropriate action.

The Bureau, as an independent law enforcement agency, ensures that Canadian businesses and consumers prosper in a competitive and innovative marketplace.

This publication is not a legal document. The Bureau’s findings, as reflected in this Position Statement, are not findings of fact or law that have been tested before a tribunal or court. Further, the contents of this Position Statement do not indicate findings of unlawful conduct by any party.

However, in an effort to further enhance its communication and transparency with stakeholders, the Bureau may publicly communicate the results of certain investigations, inquiries and merger reviews by way of a Position Statement. In the case of a merger review, Position Statements briefly describe the Bureau's analysis of a particular proposed transaction and summarize its main findings. The Bureau also publishes Position Statements summarizing the results of certain investigations, inquiries and reviews conducted under the Competition Act. Readers should exercise caution in interpreting the Bureau’s assessment. Enforcement decisions are made on a case‑by‑case basis and the conclusions discussed in the Position Statement are specific to the present matter and are not binding on the Commissioner of Competition.


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